GOVERNMENTS AND INDEPENDENT POWER SECTOR REGULATORS:

WHO DOES WHAT AND WHEN?

2007 Annual Convention of the Society of Electronic and Electric Engineers in Israel

Eilat, IsraelNovember 15, 2007

Ashley C. Brown

Executive Director, Harvard Electricity Policy GroupJohn F. Kennedy School of Government

Harvard University

Of Counsel, Dewey & LeBoeuf, LLP

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Historical Roles of Governments in Power Sector

Policy Maker

Investor /Proprietor

Regulator

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Rationales for Establishment of Independent Regulation Relieve Government's Inherent Conflicts of Interest

• Investor – Competitor

• Policy Maker – Adjudicator

• Proprietor – Regulator

Reduce Politicization in Power Sector

Enable / Facilitate Longer Term Perspective

Professionalize Regulatory Activity

Enhance Transparency

Deter Corruption

Provide Comfort Level for Private Investment in Sector

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Three Basic Areas of Regulatory Responsibility

1. Formulating and Articulation of Basic Policy

• Governmental Functions

― Basic Policy Definition: Whatever Government Says It Is

• Government Policy is Established Ex Ante

• Policy: Embodied in Law

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Three Basic Areas of Regulatory Responsibility – cont’d

2. Implement, Clarify, and Detail Policy

• Independent Regulatory Agency Functions

― Must Adhere to Articulated Government Policy (i.e. Law)

― Implement Policy Through Administrative, Legislative, and Adjudicatory Means

― Make Subsidiary Policy To Clarify, Detail, and Effectuate Basic Policy

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Three Basic Areas of Regulatory Responsibility – cont’d

3. Assuring Regulatory Accountability and Compliance

• Appellate (e,g, Judicial Review)

― ExPost Only

― Assuring Legality, Fairness, and Reasonableness of Decsions

• Government

― Reviewing and Revising Institutions, Law and/or Policy On a Prospective Basis Only

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Recurrent Theme: Balancing Independence and Accountability

Independence • Short term Political Insulation

• Ability to make Decisions Without Approval from Elsewhere

• Transparency

Accountability • Appellate (Judicial) Review

• Government (Legislative) Oversight and Prospective Change of Law

• Public Criticism

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Typical Sources of Conflict Between Government and Regulators

Failure to Fully and Clearly Articulate Policy

Overly Detailed/Rigid Government Policy

Political Interference (Often at behest of Interest Groups)

Overreaching by Regulators

Appellate Review Focused on Substance not Law, Process, and Reasonableness

Change in Government/Old Regulator Carry Forward

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Two Case Studies of Government/Regulator Conflicts

I. Brazil: Retail Tariff Formulation/Asset Valuation

II. United Sates: Transmission Pricing

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First Case Study: Brazil: Retail Tariff Formulation/Asset Valuation

Background• Distribution Companies Privatized With 5-7 Year

Indexed Tariffs In Licenses

• Privatization Preceded Formation of Market Rules and Regulatory Regime

• No Articulated Methodology for Tariff Formation or Asset Valuation

―Neither in Law nor License

• Initial Concession Period Ends With No Further Clarification

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First Case Study: cont’dBrazil: Retail Tariff Formulation/Asset Valuation

Controversy

• Regulator Must Set New Tariffs

―No Policy Guidance on Methodology for Setting Tariffs or Asset Valuation

• Companies Believe Asset Value is Based on Purchase Price

• ANEEL (Regulator) Does Not Use Purchase Price for Asset Valuation

―Employs Methodology Producing Lower Tariffs Than Companies Expect

• Distribution Companies are Generally in Poor Financial Condition as a Result of Rationing

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First Case Study: cont’d Brazil: Retail Tariff Formulation/Asset Valuation

Course of Controversy• Companies Appeal to Ministry of Finance for recourse• Minister of Finance Convenes CNPE (National Council on

Energy Policy) to Review the Matter • Ministry of Finance Conflicted Between Need for Independent

Regulation and Not Wanting to Discourage Foreign Investment• Matter is Unresolved Before new Government Takes Power• Regulator Reconsiders Decision and Employs New

Methodology, Which Produces Higher Tariffs Than Originally Proposed, but Still Less Than Companies Sought

• New Government Implements New Market Model Which Did Not Affect the Asset Valuation Methodology Adopted by ANEEL, but did Reduce Overall Risks on Distribution Companies

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First Case Study: cont’d Brazil: Retail Tariff Formulation/Asset Valuation

Outcome• Regulator was Subjected to Enormous Political

Pressures, But Did Retain Discretion to do Asset Valuation and Tariff Formulation

• Government Prospectively Changed the Market Model and Risk Allocation

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First Case Study: cont’dBrazil: Retail Tariff Formulation/Asset Valuation

Lessons• Basic Policy Needs to Be Formally Articulated Ex

Ante

• Regulator Must Fill In Gaps When Policy is not Fully Articulated

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Second Case Study: United States: Transmission Pricing

Background

• Transition from Vertically Integrated Monopolies to Open Access

• Congressional Consideration of Who Pays for Transmission Upgrades

• LMP Pricing Being Implemented

• FERC Proposes Standard Market Design With RTO’s

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Second Case Study: United States: Transmission Pricing

Controversy

• Many Utilities Want IPP’s to Pay for Transmission Upgrades

• What Distinction, If Any, Is There Between Reliability and Economic Upgrades?

• Role and Rights of “Native Load” Customers

• Terms of Competitive Access to Grid

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Conclusions

Key Criteria for Policy Making

• Essential Policies Should be Fully Articulated by Government

―Where it is Essential

―Where Predictability is Most Desirable

―Where the Public Interest So Requires

• Policy Should Be delegated to Regulator

―Where Technical Capability is Essential

―Where Politicization Might Be Most Detrimental

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Conclusions

Course of Controversy

• Many Monopoly Utilities Demand “Participant Funding” for Transmission Upgrades

• Proponents of Competition Oppose “Participant Funding

• Debate Overshadowed by Stark Differences Between Various Regions

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Conclusions

Outcome

• Congress Mandates “Participant Funding”

• Regulators Find “Participant” Very Difficult to Define―Meaningful Implementation Almost Impossible

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Conclusions

Lessons

• Delegation of Policy Making to Regulators Can Be More Prudent Course

―Competent Policy Making Often Requires Technical Expertise